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Retirement on Shaky Ground?

Robert Brokamp has the facts and the solution.

It's like a whiff of something burning in the kitchen. Or the cold breeze that tells you foul weather may be on the horizon. Or the stench that spreads when Ken Lay's in town.

I'm talking about the vague notion we all have that our retirements are in jeopardy. We've heard about the troubles with Social Security, the dwindling 401(k) accounts, and the nation's paltry savings rate, but what are the cold, hard facts?

Today, I'll give them to you, and the numbers tell a scary tale.

Social SecurityThe next time you get a paycheck, take a look at the amount taken out for "FICA," the Federal Insurance Contributions Act. That's how much you're contributing to the Social Security program, which, besides providing a retirement benefit, also provides for disability benefits, payments to certain survivors upon your death, medical care at age 65 (i.e., Medicare), and $255 to be paid to your spouse or dependents when you die. (Party!)

For most people, FICA taxes take 7.65% out of a paycheck, and the employer contributes another 7.65%. (Self-employed folks must cough up the entire 15.3%.) So, a good bit of your money goes into the Social Security program. How much will you get out of it?

Each year, you should receive a statement from the Social Security Administration (SSA) with an estimate of your benefits. You can also calculate (or approximate) your benefits on the Social Security Administration's website. The amount you'll receive is based on your work record and how much you made over the years.

Though the benefit amount will differ for each individual, we can tell you that for 2003, the average monthly retiree benefit was $895, or $10,740 per year. While that would be a lot of money to find under the couch cushions, it's not much to live on. However, according to the SSA, two-thirds of retirees rely on Social Security to provide 50% or more of their income. For 20% of retirees -- one in every five -- Social Security is the only source of income. Scary.

If that's the case now, what will happen in the future when the baby boomers put a huge strain on Social Security? Again, let's look at the numbers.

Current taxpayers pay today's Social Security benefits; your taxes become a retiree's lunch money. Right now, there are more taxes going in than money coming out, so trust funds accumulate the difference (except when the government spends it, but that's another story). However, once the baby boomers begin retiring, the worker-to-retiree ratio will shrink from a current 3.4 to 2.1 by 2030. But long before then -- 2017, to be approximate -- the Social Security program will have to pay out more than it takes in, and the money in trust funds will have to make up the difference. By 2041 (according to current projections, which are to be taken with a planet of salt), trust funds will be depleted.

To bring the program into "actuarial balance" would require a permanent 13% reduction in benefits, a 15% increase in taxes, or a combination of the two, according to the SSA.

So the lesson here is you can't count on Social Security to replace a large portion of your pre-retirement income. Will the younger folks get anything from Social Security? Most likely, but it will be less than what current retirees get, and at a greater cost.

Traditional pension plansTime was, a fella would work for the same company for 30 years, and then retire, receiving a monthly pension check for the rest of his life (which, back in the good old days, didn't last as long as a life does today). Now, such arrangements (known officially as "defined-benefit plans") are in decline. In 1986, 172,642 companies offered traditional pension plans. By 1998, that number had shrunk to 56,405, according to the Employee Benefit Research Institute.

What happened? Companies decided it was cheaper and easier to shift the responsibility and risk of retirement savings onto the employee.

There's another disturbing trend afoot. Many defined-benefit plans are underfunded, thanks to the bear market, lower interest rates, and aggressive accounting. Pensions can be terminated and benefits cut, as pilots at U.S. Airways are finding out. Workers do get some protection from the Pension Benefit Guaranty Corporation, which, very loosely, is to pension plans what the FDIC is to banks.

So, the security that was the good, old company pension plan is not what it used to be. But companies haven't completely abandoned employees' retirement dreams. Many offer retirement plans that provide some sweet tax advantages. Some companies will even contribute to these accounts on their employees' behalf. But it all relies on an employee signing up and forgoing current income. Of course, we're talking about...

Defined-contribution plans (and other savings)The final leg of the proverbial three-legged stool upon which your retirement will rest is personal savings. This is the leg Americans have the most control over, and, for many, will have to provide the bulk of retirement income. So, how are we doing?

In a recent speech, Federal Reserve Board Gov. Susan Schmidt Bies said three-fourths of eligible employees participate in a 401(k) plan, the most common employer-sponsored retirement savings account, contributing an average of less than 4% of pay each year. Among households with people close to retirement age, one-half had saved less than $55,000, and one-quarter had less than $13,000.

A study by the Congressional Research Service found that of all workers (not just those eligible for a retirement plan at work), just 42% have a retirement account. Three-fourths of workers age 55 to 64 have less than $56,000 saved.

Again, this would be a nice chunk of change if you found it in an old trunk you bought at a flea market, but it's not enough to sustain truly golden years. A retiree shouldn't expect to withdraw more than 6% of her savings a year in retirement, if she doesn't want to outlive her money. Thus, a nest egg of $56,000 will provide just $3,360 in annual income. Couple that with the $10,740 average annual Social Security benefit, and you get $14,100. That won't buy a lot of trips to Denny's.

What about you?Enough about averages. What matters to you is how much you'll receive from Social Security, your pension (if you have one), and your savings. Here's what to do:

Locate your most recent Social Security and defined-benefit estimates, as well as account balances for retirement accounts.

If you need to save more, figure out how much, and dissect your budget to come up with the money.

Choose the best retirement account. If your employer matches contributions to the retirement plan at work, start there, and take the advantage of that free money. Otherwise, consider an IRA. You still have until April 15 to make your contribution for 2002.

We have limited control over the Social Security program and our company's pension, but we can control how much we save. That's where an individual can make a huge difference in their prospects for retirement.

Robert Brokamp can't imagine enjoying doing nothing all day -- but he's saving for retirement, just in case he changes his mind. The Motley Fool is investors writing for investors.

Author

As a former financial advisor and English teacher, it was inevitable that Robert Brokamp would one day write about the management of money. His musings on retirement, investments, budgeting, and whoopee cushions can be found on Fool.com and in various other publications, including Better Investing and Newsweek. He was a contributor to The Motley Fool's Money After 40, the co-author of The Motley Fool Personal Finance Workbook, the author of The Motley Fool's Guide to Paying for School, and is the editor of the Motley Fool Rule Your Retirement newsletter service. Robert wishes to one day definitively answer the question, "Why do we make bad decisions with our money when we know better?"
Robert lives peripatetically in Alexandria, Va., with his wife and four children -- but on autumn Sundays he wishes he were in Raymond James Stadium or wherever the Tampa Bay Bucs are battling.